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Married Puts: A Way to Get the Cow and the Milk for Free

Brian Louis

If you did some bottom-fishing in technology stocks last year, or early this month for that matter, odds are you went through some pain.

Owning a put option on your bottom-fishing candidate would have helped you avoid that wrenching feeling of being separated from your money. With that put option in place, you would have had insurance on your long stock position, as well as a few good nights' sleep.

Not that you necessarily should be, but if you insist on bottom- fishing in this ugly market, the married put strategy is a good thing to know about. A married put is the simultaneous purchase of a put and a corresponding amount of the underlying security.

If the stock position appreciates, you've lost what you invested in the put. Then again, you used the insurance to make the stock purchase more palatable. If the stock falls, the put option gives you the right to sell the stock at the option's strike price.

So, you may say, "I'll just put a stop-loss limit order in place once I buy the stock and that will protect me. I won't need to buy the put." Perhaps you should think again.

There is a downside to the stop order in that it can be "triggered at a time and at a price unacceptable to the investor," according to the handy The Equity Options Strategy Guide brochure from the folks at the Options Industry Council.

For example, you buy the stock of a company you think has bottomed out. But considering how many companies have issued earnings warnings in the past few months, if you owned that stock, and the company warned after the bell, even your stop-loss limit may not have done you much good. Say you had a stop at $40, but the stock opened down to $35 and kept slumping and your order finally got filled at $34 -- with a married put strategy in place, you wouldn't have had to worry about a situation like that.

"If there is a sudden, significant decrease in the market price of the underlying stock, a put owner has the luxury of time to react," the OIC booklet says. So if the stock you bought one day collapses, you wouldn't have to sell right away to cut your losses in the case of the stop. During the lifetime of the put option, you could exercise the put and sell the stock at the strike price, no matter where the stock is trading.

The maximum profit of a married put position is unlimited, in theory, the OIC points out. The maximum loss is limited, fortunately. The maximum loss is calculated by the price the investor paid for the stock, minus the strike price of the put plus the premium paid for the put.

Here's an example. You think Cisco(CSCO Quote) has been beaten up enough, and you're expecting the stock to rebound. Here's how you'd use a married put strategy on Cisco.

Cisco is trading at $19.63 Thursday afternoon, when you buy 100 shares. You also buy one May 20 Cisco put option contract, trading at around 2 5/8 ($262.50). You think about just buying an April put, but that option expires before the company posts earnings on May 8, and you'd prefer to have downside protection in place for earnings. So you buy the May 20 put, which is slightly in the money, and slightly more expensive than the similar April contract.

Excluding commissions, buying the put will cost $262.50, while 100 shares of Cisco will cost $1,963, for a total of $2,225.50. However, the most you could lose if the trade goes south on you is $225.50. The put locks you in to sell at $19.

Of course, if the trade goes your way and you want to take profits and sell the stock, obviously you can do that. Also, you can sell the put to recoup a little bit of the premium you paid and close out the position if the underlying stock rallies.

So, in a market that has made buying the dip a horribly anxiety-inducing practice over the last year, using married puts is a recipe for a little bit of comfort.